Investing Focus: Is Now a Good Time to Invest in Japan?
Corporate governance reforms, rising wages and a pro-growth government are drawing investors back to Japanese equities — here's what you need to know
Written by Boring Money
17 Feb, 1970
Japan is back on investors' radar. A pro-growth government, rising wages and a decade of corporate governance reform have sent the Nikkei surging — but with valuations stretched and global risks in play, is the best of the rally already priced in? We explain what's driving Japanese markets and how UK investors can get exposure.
The Japanese election at the start of February was a resounding victory for Prime Minister Sanae Takaichi. It was also a clear mandate for her expansionist economic programme, which promised to “spend for growth” and revive the Japanese economy.
The Japanese economy was already changing. After years of deflation and zero or negative interest rates, inflation has revived in the post Covid era. While the rest of the world is desperately trying to avoid inflation, for Japan, it represents progress and a return to growth. Initially, price rises were led by external factors, such as commodity price rises, but it has become a domestic story, driven by wage growth and services price increases.
GDP growth has been positive for the last five years, albeit unexciting. The IMF is forecasting growth of 0.6% for 2026[1]. Japan’s debt burden remains astonishing, with government debt running at 227% of GDP. For context, the UK’s debt to GDP is 105%, and the US’s figure is 129%[2]. However, because the debt is largely held domestically (90%), yen-denominated, and supported by the Bank of Japan, it is seen as less of a concern than for countries reliant on external support.
The real excitement for investors has come from the corporate governance reforms, started under Prime Minister Shinzo Abe as part of his ‘three arrows’ economic strategy. Abe sought to boost productivity by reducing corporate taxes, improving corporate governance, and increasing workforce participation. The Corporate Governance code was introduced in 2015 and triggered a fertile period for reform.
Companies have taken steps to reduce cross-shareholdings between companies. Management teams are targeting higher return on equity, putting their vast cash reserves to work. Merger and acquisition activity is slowly picking up, and dividend
payouts and buybacks are being used to improve share price performance.The Ruffer Investment Trust has a significant position in Japanese equities with the aim of targeting this shift.
We are looking to exploit the ongoing improvements in corporate governance and shareholder friendliness in Japan. This has been going on for the best part of a decade, but valuations are still very attractive. The actions that we are seeing from policymakers and companies give us confidence that this is a trend with real longevity.
“In terms of what we own, some of these are good global companies where the capital allocation could be a bit better. Some are weaker companies, where the balance sheets are hoarding excessive amounts of cash. It’s a real range. They should all be lifted by the ongoing improvements in corporate governance.
This change has been an important driver of change in Japanese stock markets and has helped bring Japanese equities to the attention of investors again after years when they held little interest. The Nikkei remains one of the best-performing indices of the last five years, having doubled since 2020[3].
Japan markets
The main index in Japan is the Nikkei, which comprises the top 225 stocks on the Japanese Stock Exchange by market capitalisation. There is also the TOPIX, which tracks the entire market of domestic companies. To track small
and mid cap Japanese stocks, investors can use the MSCI Japan SMID Cap index or the JPX-Nikkei Mid and Small Cap index.The Nikkei is heavily weighted to technology companies, which comprise 53% of its overall capitalisation. These include companies such as Advantest, which makes automatic test equipment for the semiconductor industry, technology aggregator and investor Softbank group, robotics group Fanuc and telecommunications group KDDI. The Japanese market has been subject to the same phenomenon as other major markets, with the AI trade propelling technology groups forward.
Many of Japan’s industrial companies have slipped down the rankings more recently. In particular, its once dominant auto sector has struggled from a combination of US tariffs, Chinese competition and the rise of electric vehicles. Sales for companies such as Honda, Nissan, Mazda and Suzuki have been struggling for years. Equally, its consumer electronics sector – Sony, Panasonic – has had to fight for airtime with investors preoccupied by AI. These have become a less important part of the index.
Japan has a healthy and diverse small and mid cap sector, which holds a range of niche industrials, consumer discretionary and technology companies. It includes fibre-optic cable company Sumitomo Electric Industries, golf club maker Fujikura, or life sciences group Astellas.
One persistent problem for investors in Japan has been the impact of the currency. If the Yen is strong, it makes it difficult for export-heavy companies to make progress, weakening their share prices. For international investors, they may benefit on the currency and lose on the share price return. The opposite is true when the yen is weak. This is less of a problem now that exporters are a smaller share of the Japanese market.
Carl Vine, manager of the M&G Japan fund, says this is less of an impact than may initially appear: “Around 50% of the index might be classified as exporters, but then a lot of those are internally hedged, so the exposure is actually not as high as people think.” Nevertheless, it is factor for investors to bear in mind.
Recent performance
Japanese markets have been extremely strong. The Nikkei is up 45% over the past 12 months[4], as investors have increasingly bought into the reflation and reform stories in Japan. The index has surged since Takaichi’s victory, with investors anticipating stronger economic growth from fiscal expansion. There has been particular strength in areas targeted for government spending plans.
In equity markets, the so-called “Takaichi Trade” is well understood, with pronounced moves already evident in sectors expected to benefit from her policy priorities. Companies exposed to technology, AI, semiconductors and defence have led performance, reflecting expectations of targeted fiscal support and strategic investment. While it remains unclear whether the proposed removal of the consumption tax will be pursued, any such move would provide an additional tailwind for domestic consumption and should be supportive for retailers and other domestic consumer-facing businesses.
Outlook
The economic backdrop still looks relatively strong for Japan. Naomi Fink, chief global strategist at Amova Asset Management’s says Japan’s full-year 2025 real GDP growth estimates are well above potential, at 1.1%, following negative readings in both 2024 and 2023. A big part of this was domestic consumption and private non-residential investment, all growing well above 1% over the full year.
The Bank of Japan has highlighted why we should pay greater attention to wage-price dynamics as a forward-looking indicator of Japan’s reflationary potential. Firstly, for households, real balances matter and for households, this means whether wages are growing more quickly than the prices of goods and services in their consumption basket.
She adds that there are also now expectations of significant fiscal stimulus from Takaichi’s election victory.
Corporate governance reform is likely to be a continued driver for markets, with backing from Takaichi.
The larger end of the market has seen the benefits of these reforms, and we are seeing these tailwinds increasingly trickle down to small- and mid-cap companies through higher domestic demand, better pricing power, improved balance sheet discipline, and more shareholder-friendly behaviour.
The AVI Japan Opportunities trust has around 60% in sub-$1bn opportunities to target this shift.
Vine is optimistic that these reforms can continue to deliver strong earnings growth. He points out that Japanese companies have a history of delivering strong earnings in a difficult environment and the economic backdrop is now improving: “The corporate sector in Japan deserves a bit of credit for having grown earnings in what was otherwise, at least domestically speaking, a low growth environment.” He says corporate self-help is “still delivering tangible results. Look at the growth of dividends, share buybacks…There's still a lot of readily available optimisation strategies that companies can deploy to continue to grow their returns.”
There are risks. Japan is not immune to the energy shocks in the global economy. At the same time, while growth is strong by Japanese standards, it does not look particularly impressive compared with the rest of the world. Equally, Japanese markets have moved a long way and now look more expensive. This gives them less cushion if the global economy weakens.
Ways to access
Japan may be one of the largest stock markets in the world, but it is still only lightly represented in global stock market indices. It is only 6% of the MSCI World index, for example[5] (#_ftn5). Equally, many Asia-focused funds and investment trusts specifically exclude Japan, focusing instead on China, India, Korea and Taiwan.
Investors wanting more targeted exposure can pick a dedicated Japan fund. The top-performers over the past three years have tended to be value focused funds, such as WS Morant Wright, M&G Japan or Fidelity Japan. Historic strong performers that specialise in growth companies and/or smaller companies, such as Baillie Gifford have had a more difficult run. Investors could also look at investment trusts, where the average discount to NAV is 8.2%.
ETFs are another option, with funds tracking the MSCI Japan, Nikkei, plus high dividend or smaller companies options. There are hedged and unhedged versions, in case investors want to minimise currency exposure and also leveraged options for investors who want higher exposure.
[1] (#_ftnref1) https://www.imf.org/external/datamapper/profile/JPN
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[2] (#_ftnref2) https://www.imf.org/external/datamapper/profile/USA
[3] (#_ftnref3) https://www.marketwatch.com/investing/index/nik?countrycode=jp
[4] (#_ftnref4) https://www.marketwatch.com/investing/index/nik?countrycode=jp
[5] (#_ftnref5) https://www.msci.com/documents/10199/178e6643-6ae6-47b9-82be-e1fc565ededb
